Description
Discuss the limitations of ratio analysis.
Read the following article on major limitations of ratios analysis and give feedback.
https://www.accountingtools.com/articles/what-are-the-limitations-of-ratio-analysis.html
Explanation & Answer
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Ratio analysis is a technique that is commonly used in industries and small companies to
determine the financial status of a firm. Ratio analysis has several issues that limit its use. The
following are its limitations:
1.
Incorrect results are obtained in case of use of wrong accounting data.
When the accounting data is being keyed in or being collected, it is essential that we acquire
accurate data to facilitate accurate results after the ratio analysis is carried out. There are cases
where the financial statements are affected by window dressing. Window dressing is the act of
displaying a position in a better way than it is. This indicates that there will be an exaggeration
and the financial statements obtained will be inaccurate.
2.
No predictions of the future.
Ratio analysis is carried out using the actual historical results, but this does not guarantee the
possibility of predicting the happenings in the future. The results obtained help us to know only
the current financial status of a firm. This is a limitation that is currently being considered vital
since people are in need of being aware of the probable happenings in the future considering that
the business h...
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